Federal Reserve Minutes: Interest rates can only be lowered if inflation continues to decline, but Trump's policies pose an upward risk to inflation

Key Points:

The Federal Reserve's January meeting minutes show that officials reached a consensus during the January meeting, believing that inflation needs to continue to decline before any further rate cuts can be made.

Participants noted that there are upside risks to the inflation outlook, particularly mentioning the potential impacts of changes in trade and immigration policies.

The minutes also mentioned a considerable degree of optimism regarding the economic outlook, partly due to market expectations of regulatory easing or changes in tax policy.

Officials also discussed whether to slow down or pause the reduction of its nearly $6.8 trillion asset portfolio. "New Federal Reserve Correspondent" Nick Timiraos stated that this is due to the complex issues arising from raising the federal debt ceiling that the Fed will face in the coming months.

The Federal Reserve meeting minutes indicate that maintaining a restrictive policy during strong economic conditions is desirable, and they hope to see further progress on inflation before adjusting interest rates.

The January meeting minutes released by the Fed on Wednesday show that officials reached a consensus during the January meeting, believing that inflation needs to continue to decline before any further rate cuts can be made, and expressed concerns about the potential impact of President Trump's tariff policies on inflation.

New Federal Reserve Correspondent: Possible Slowdown or Pause in Balance Sheet Reduction

Wall Street Journal reporter Nick Timiraos, known as the "New Federal Reserve Correspondent," wrote that the Fed's January meeting minutes show that officials discussed whether to slow down or pause the reduction of its nearly $6.8 trillion asset portfolio last month, as they face complex issues arising from raising the federal debt ceiling in the coming months.

Timiraos pointed out that market dynamics related to the debt ceiling could lead to significant fluctuations in the reserves on the Fed's liability side. Reserves are deposits that banks hold at the Federal Reserve.

Since mid-2022, the Fed has been reducing its balance sheet to reverse the accommodative monetary policy (QE) implemented during the COVID-19 pandemic. However, the balance sheet reduction process will ultimately deplete the reserves in the banking system, and Fed officials are currently uncertain about how long this process will last.

How the U.S. Treasury manages its cash balances, which can cause fluctuations in the money market, may complicate the Fed's ability to determine the correct reserve balance.

Therefore, according to the minutes, officials at the January meeting believed that "considering a pause or slowdown in the balance sheet reduction until the debt ceiling issue is resolved may be appropriate."

At the same time, Bloomberg analyst Cameron Crise also stated that the discussions in the minutes regarding further slowing or even pausing the balance sheet reduction could significantly disrupt reserve levels. He believes that if the Fed keeps the balance sheet size unchanged during this process, it would help alleviate the sudden drop in reserve levels to "adequate" levels (i.e., slightly below current levels) and prevent liquidity from being squeezed.

Participants: Rate Cuts After Inflation Improvement

At the January meeting, the Federal Open Market Committee (FOMC) unanimously decided to keep the key policy rate unchanged. The minutes show that when making this decision, participants discussed the potential impacts of the new Trump administration, including discussions about tariffs and the potential effects of reduced regulation and taxationThe committee pointed out that compared to the policy environment before the interest rate cuts, the current monetary policy is "significantly less tight," which gives members time to assess the economic situation before taking further action.

Participants stated that the current policy provides "time to assess the outlook for economic activity, the labor market, and inflation changes." The vast majority of members believe that the Federal Reserve's current policy stance still has a certain degree of tightness. The meeting minutes stated:

“Participants noted that as long as the economy remains close to maximum employment levels, they would like to see further progress in reducing inflation before taking additional adjustments to the federal funds rate target range.”

“Many participants noted that if the economy remains strong and inflation remains high, the committee could maintain the policy rate at a restrictive level.”

Officials expressed concerns that changes in fiscal policy could lead to inflation remaining above the Federal Reserve's target.

Federal Reserve: Trump's policies pose upside risks to inflation

Currently, U.S. President Trump has implemented some tariff policies, but in recent days, he has threatened to further expand the scope of tariffs.

In a conversation with reporters on Tuesday, Trump stated that he is considering imposing a 25% tariff on the automotive, pharmaceutical, and semiconductor industries, which will be gradually implemented within this year. Although he did not provide details, these tariff measures will usher trade policy into a new phase and further raise price levels in the context of current inflation easing but still above the Federal Reserve's 2% target.

The meeting minutes showed that FOMC members mentioned,

“The potential impacts of changes in trade and immigration policies, as well as strong consumer demand. Business contacts in multiple regions indicated that companies will attempt to pass on higher input costs resulting from potential tariffs to consumers.”

They further pointed out:

“ There are upside risks to the inflation outlook, particularly as participants mentioned the potential impacts of changes in trade and immigration policies.”

Since the January meeting, most Federal Reserve officials have maintained a cautious stance regarding the direction of policy. The majority believe that the current interest rate levels allow them ample time to assess how to proceed with policy adjustments.

In addition to the employment and inflation issues typically focused on by Federal Reserve officials, Trump's fiscal and trade policy plans have also added complexity to decision-making.

Beyond concerns about tariffs and inflation, the meeting minutes also mentioned, “There is considerable optimism about the economic outlook, partly due to market expectations for a relaxation of government regulation or changes in tax policy.”

Many economists believe that the tariffs planned by Trump will exacerbate inflation, although Federal Reserve decision-makers have stated that their policy response will depend on whether these tariffs lead to only one-time price increases or trigger deeper inflationary pressures that would require policy responses.

Recent inflation indicators have shown mixed results, with the Consumer Price Index (CPI) in January exceeding expectations, while the Producer Price Index (PPI) indicated a reduction in price pressures in the supply chain.

Federal Reserve Chairman Powell has generally avoided speculating on the potential impacts of tariffs. However, other officials have expressed concerns and acknowledged that Trump's measures could affect monetary policy and potentially delay interest rate cuts furtherCurrently, the Federal Reserve's target range for the benchmark overnight borrowing rate is 4.25%-4.5%. According to futures market pricing, investors currently expect one rate cut in 2025, and possibly a second rate cut, with the next rate cut potentially occurring in July or September